Since the Federal Reserve announced its groundbreaking new strategy last week to try to get the U.S. economy on track there have been some big open questions. The biggest: Just what would qualify as "back on track"?
Now, one Fed policymaker is offering some specific—and surprising—answers. Narayana Kocherlakota, president of the Federal Reserve Bank of Minnesota, laid out in a speech Thursday what he calls a “contingency plan for liftoff.” Here’s the most important part: He argues that “as long as the [Federal Open Market Committee] satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent.”
He could hardly be clearer. As long as inflation isn’t a problem, Kocherlakota is saying, the Fed should keep its foot all the way on the gas pedal until unemployment drops from its current 8.1 percent down to 5.5 percent.
What makes it particularly surprising is that Kocherlakota is generally viewed as one of the more hawkish, or inflation-phobic, members of the FOMC. He dissented from two moves by the Federal Reserve to ease policy in 2011. Yet this proposal goes further than that of arguably the biggest dove on the committee, Charles Evans of the Chicago Fed. Evans has proposed that the Fed pledge to keep easy monetary policy in place until either unemployment drops below 7 percent or inflation rises above 3 percent.
That said, Kocherlakota still appears less willing than Evans to tolerate a bump in inflation. In Thursday’s speech at Gogebic Community College in Ironwood, Mich., he proposed that the Fed use 2.25 percent inflation as a threshold for raising rates. That is only slightly higher than the Fed’s 2 percent target for inflation, so Kocherkakota has kept some of his hawk’s feathers. He also specifically noted that, contrary to many assessments of Fed strategy, he does not view higher inflation as a Fed goal. Rather, he hopes that easing policy will boost the confidence of businesses and consumers, leading them to expect lower future unemployment.
Referring to Evans in his speech Thursday, Kocherlakota said: “I very much liked his approach to thinking about the problem. Those familiar with his plan will see that my thinking has been greatly influenced by his.”
Kocherlakota has been a leading Fed advocate of the argument that unemployment is substantially partly "structural" in nature -- that is, workers' skills are mismatched with areas where there is demand. His proposed plan for liftoff isn’t necessarily in conflict with that thinking. If he turns out to be right that the long-term potential for the U.S. economy is less than it once was, then inflation would likely rear its head before the jobless rate falls to 5.5 percent, ending the era of easy money. If economists who see little evidence for these structural arguments are correct, then the inflation coast should be clear until unemployment has fallen to about that level.
Still, coming from someone who has dissented from the majority of the committee in the recent past, Kocherlakota's remarks suggest that consensus on the FOMC for the new policy regime announced last week is deep. And that’s crucial, as for the promises to keep supporting the economy as long as it needs it to carry any punch, the world must believe that the Fed will remain committed to the plan even when Chairman Ben Bernanke’s term is up in 2014.
Kocherlakota’s comments point to a Fed that, despite some dissents, is largely united in its goals and strategy. And that’s the way, Kocherlakota said Thursday, it’s supposed to work.